Measure will stifle enterprise, business leaders tell ministers

Wednesday 10 October 2007 19.03 EDT
First published on Wednesday 10 October 2007 19.03 EDT

Business leaders yesterday called for the government to reverse an 80% tax rise on investors in small companies after they claimed that measures in the pre-budget report could spell the end for Britain's entrepreneurial culture.

"It will discourage investment right across the economy and entrepreneurs who have toiled to build up businesses from scratch will be particularly hard hit," said John Cridland, deputy director-general of the CBI, employers' body.

The Federation of Small Businesses said a move to increase taxes on private equity by the chancellor Alistair Darling had caught smaller companies in the crossfire.

Companies listed on the Aim junior market would suffer as the rewards for investing in high-risk ventures were stripped away, tax experts added. The small business group said it would begin lobbying ministers to overturn the rise in capital gains tax from 10% to 18%. It said it would ask the government to include measures that protected smaller companies from the tax increase.

The CBI claimed the new CGT tax regime would have an impact beyond the private equity sector. "The Treasury needs to think carefully about the signal this decision sends out on enterprise."

Opposition parties said the attack on private equity had backfired. The Conservatives said Mr Darling had almost doubled the tax on so-called Dragon's Den business angels who had taken risks with their investments only to see the reward of a low tax rate stripped away.

Ministers last night stood by their decision to set a flat rate for capital gains tax. The 18% rate will take effect next April and will supersede a tapered scheme that currently charges tax at 40% if business assets are sold in the first year but shrinks to 20% in the second year and 10% if assets are held for longer than two years.

Private equity firms are the chief target of the reforms after a successful year for the industry that critics argued was largely built on low taxes. High-profile takeovers of Boots Alliance and the prospect of a buyout of Sainsbury prompted unions to claim that the private equity industry benefited unfairly from tax rates designed for entrepreneurs.

Partners in private equity firms typically hold their investments for between three and five years to benefit from the 10% tax rate on their capital gains.

The Treasury said the reforms were part of a wide-ranging simplification of the tax that would result in benefits for all investors. A spokesman said the business community had called for tax simplification and the government listened to their arguments. Many individuals with capital gains in excess of the £9,200 threshold could calculate their tax bill without expensive advisers, said one Labour MP.

Second home owners and buy-to-let flat investors stand to gain the most from the new flat rate system. They can cut their tax bill to 24p in the £1 under the existing regime and will enjoy a further reduction of 6p to 18p after April 2008.

Tax experts, including the Chartered Institute of Taxation welcomed the reforms which they said offset some of the growth in complex tax rules in recent years.

Unions said the rise in tax for private equity justified the move, which they argued meant the industry would begin paying a fairer share of their income in tax.

However, stockbrokers supported the claims of the business community that investors in small private companies and firms listed on Aim would suffer badly.

They said the Aim market would be a particular loser because investors would now face the same tax regime whether they invested in small companies or firms in the FTSE 100.

This might skew investment away from the riskier small companies sector to safer large company bets.

Charlotte Black, of Aim company adviser Brewin Dolphin, said: "Trustees and private investors in Aim companies were effectively treated as entrepreneurs and encouraged by fast-track taper relief of 10% after 2 years to bear the higher risk for potentially extra reward. That incentive has now been retrospectively removed and investors who took this extra risk will now be rewarded with an 80% tax increase. The sledgehammer designed to crack the private equity nut has hit all entrepreneurs and Aim investors very hard."

Stockbroker Killik & Co said the move could spur a huge sell-off of Aim stocks before the end of the tax year.

Tax experts pointed out that employees in company share schemes would also be forced to pay more tax, running against the grain of government initiatives to boost private share ownership.

KPMG spokesman Greg Limb said: "Employee shareholders will be eight per cent worse off when they dispose of their shares than at present whereas an investor who doesn't work for the business, could be up to 22% better off."

Winners and losersCurrently CGT on business assets is paid at 40p in £1 in the first year on gains over £9,200. If the asset is held for one year, the rate is 20p in the £1, and 10p after two years. Taper relief on non-business assets also starts at 40%, but falls to 24% after 10 years. Mr Darling said the new 18% tax rate would apply across the board to business and non-business (usually investment) assets.

WINNERS

Holders of non-business assets - second home owners and buy-to-let investors - and investors in art and antiques will benefit from an 18% flat rate.

LOSERS

Entrepreneurs such as Sir Alan Sugar (left) will lose when they sell their businesses, as will investors in companies listed on the Aim market. Private equity and venture capital firms that enjoyed the taper relief to 10% will also lose. Employees who invest in save as you earn share schemes run by their employer will also pay more.